Case — Federally Authorized Tax Practitioner Privilege

THE QUESTION

Do handwritten notes of a meeting between a federally authorized tax practitioner and a client qualify as confidential communication not subject to disclosure to the IRS?

THE DISPUTE

Taxpayer Says: The notes do not have to be disclosed because they are not written communications in promotion of a tax shelter and therefore are not disqualified from being considered confidential communications.

Internal Revenue Service Says: The notes should be disclosed because they are related to promoting the taxpayer’s participation in a tax shelter transaction and fall under an exception to the privileged communications rules.

THE LAW

From Internal Revenue Code Section 7525(a)(1): Provides a limited privilege, equivalent to the attorney-client privilege, to communications regarding tax advice between a taxpayer and any federally authorized tax practitioner.

From Internal Revenue Code Section 7525(b): Section Not To Apply to Communications Regarding Corporate Tax Shelters.–The privilege under subsection (a) shall not apply to any written communication between a federally authorized tax practitioner and a director, shareholder, officer, or employee, agent, or representative of a corporation in connection with the promotion of the direct or indirect participation of such corporation in any tax shelter (as defined in section 6662(d)(2)(C)(iii)). [Editorial Note: This is pre-October 21, 2004 code, which applies to this case; see case for updated wording.]

From United States v. BDO Seidman, L.L.P., 492 F.3d 806, 821 (7th Cir. 2007): For the federally authorized tax practitioner privilege not to apply because of the application of the section 7525(b) exception, evidence must be produced indicating that all the elements of the exception are satisfied.

THE CAUSE OF THE DISPUTE

As a general rule, certain oral and written tax advice you receive from your certified public accountant or other “federally authorized tax practitioner” (CPAs, attorneys, enrolled agents and enrolled actuaries) can be considered privileged information, not subject to disclosure.

This confidential communications privilege is extremely limited. In addition, it applies only to the extent the communication between you and your tax advisor would be privileged if you were speaking to your attorney instead. Advice involving tax shelters is specifically exempted from the privilege.

In this case, the dispute arises over the definition of the terms “promotion” and “written communication” in the tax shelter exception, neither of which are defined in the code.

The communication in question is the handwritten notes of the taxpayer’s accountant, who met the definition of a federally authorized tax practitioner. The notes summarize advice the preparer gave the taxpayer, a limited partnership, about tax aspects of a series of partnership redemption transactions that the IRS considers a tax shelter. The IRS wants the notes for review. The taxpayer contends the notes are privileged.

The taxpayer says the notes are not “written communications” because that phrase requires some transmission of written material from one person to another, and the preparer did not share his notes with any other person. In addition, the advice given by the preparer was not promotional. Instead, it was part of the normal course of a long-term advisory relationship, within the preparer’s field of expertise, and the preparer had no stake in the advice beyond his employer’s right to bill hourly for his time.

The IRS takes the position that “Written notes of oral communications are ‘written communications’ under any plausible construction.”. The IRS also argues the preparer’s relationship with the taxpayer means the preparer played a substantial role in structuring the transactions and was involved in organizing, structuring and assisting with respect to them, and that these activities meet the definition of promotion.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

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✓Right answer!

Sorry, wrong answer :(

For the Taxpayer. The notes were not communicated to anyone. Therefore, they do not constitute a written communication that can satisfy that element of the section 7525(b) exception. The privilege accorded to the notes is not subject to the exception in section 7525(b). In addition, the IRS failed to show that the preparer crossed the line from adviser to promoter. The communications remain privileged.